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HEXO's pot strategy is to focus on Canada - and it's working

An employee displays cannabis buds in a posed photo at Hexo Corp’s facilities in Gatineau, Quebec, Canada, September 26, 2018. (REUTERS/Chris Wattie)

In the days following the legalization of recreational marijuana in Canada, HEXO was quick to send out a press release touting its ability to meet demand where other companies had fallen short.

“HEXO has risen to the challenge of a much higher than anticipated demand during the first few days of legalization, and we are very pleased with their responsiveness,” said Jean-François Bergeron, the Société des alcools du Québec’s Vice-President of Supply Chain, in the release. “Thanks to HEXO’s preparedness, we have been able to provide and maintain customer service to the SQDC’s clients, even with this higher demand.”

Amid a mixed earnings season for major cannabis companies including AuroraCronos, Tilray and Canopy Growth, investors interested in making money off marijuana may be looking for some alternatives (although some would argue the time to make money off legalized weed in Canada has already passed us).

HEXO’s confident swagger aside, the cannabis producer remains of interest for marijuana market investors. The company, formerly known as The Hydropothecary Corporation, launched in 2013. The Gatineau, Quebec-based producer has a market cap of $1.154 billion — about a tenth of Canopy Growth’s on the TSX. But that hasn’t stopped the small dog from having a big dog mentality.

“HEXO themselves views their peers as being Canopy and Aurora. Pretty much to an exclusion of everything else,” says Andrew Udell, managing director of The Cannalysts (note: The Cannalysts strictly provide analysis of stocks, and not advice as to which stocks to purchase).

Udell says there are two key things which set HEXO apart from the bigger players in the space (for better and for worse): its regional focus, and its product offerings.

Focused on their own backyard

“HEXO is largely regional in focus,” says Udell, explaining that they’ve struck supply deals in Quebec, Ontario, Alberta, B.C. and Saskatchewan. “They are littered about the Canadian landscape, but they’ve effectively preempted themselves from any U.S. markets, at this point.”

While other cannabis producers are heavily focusing on overseas markets and eventual expansion south of the border, HEXO has opted to stay within Canada.

“They have no interest in going anywhere, any jurisdiction where cannabis is unlawful or illegal,” says Udell.

“Being that they are Quebec-basesd, their primary offtake is through the Quebec government, as well…They have, I think, 20,000 kilograms, [a] fair amount, put out, anticipated to be sold within the first year of legalization, and mainly in Quebec.”

The focus on the provincial market offers some protection to the company (and in turn, investors) that other producers don’t have.

“The heavy presence in Quebec provides them some sort of ring fence, maybe a little bit more of a Quebec feel to it,” says Udell. “Their retail expansion, which is again, was going to be a large part of the HEXO platform, they do have several strategic alliances, ownership initiatives, ventures available.”

But that heavy regional focus can also lead to problems, and fewer alternative avenues to fall back on.

“I think that the headwinds that they’re facing is that there’s going to be a delay that’s beyond their control,” says Udell.

“If Quebec is facing the same logistical constraints of getting this product to market, then that just backs up all of those revenue expectations that were expected to happen on October 17.”

Different product line

Back in August, HEXO became a household name because of the blockbuster deal it landed with Molson Coors. The joint venture would see the companies develop non-alcoholic cannabis-infused beverages.

Despite the splash the news made at the time, Udell says that alone hasn’t been enough to make HEXO a guaranteed winner.

“Even with Molson Coors, I suspect why that [joint venture] is not as greeted as enthusiastically as say, Constellation’s entry [investing in Canopy Growth] is because it is a joint venture,” says Udell. “It’s not an equity take by Molson Coors. And it’s only centered around drink products, non-alcoholic drink products. And that product suite is definitely years away. I’d say 18 to 24 months at least. I can see drinks as being more problematic, even, maybe 48 months out.”

One of the biggest challenges that partnership faces is getting the product out to market legally.

“Edibles, which [beverages] would fall under, is a completely different animal,” says Udell. “I know Health Canada’s running hot and horny to get it to begin consultations in December and getting some working regulations for comment out by February. I can’t see that possibly happening in this lifetime.”

But edibles aren’t the only thing HEXO is banking on. They currently have some unique cannabis products, including an intimate spray, peppermint-flavoured medical products, and a cannabis powder for medical use. They also “vintage” their products, in order to differentiate themselves from the competition.

“Their novel product line, or some of their product suite, they’re probably one of the more advanced out there,” says Udell. “Aurora being the only competitor who’d probably be in the same space as that.”

While it may not be as globally exposed as some of its competitors, investors who are looking to get into the pot game could still find some reasons to explore HEXO.

“If you’re looking for a company that will have production that’s looking for a view towards novel products, novel product designs, and has ostensibly, whether international or not, a very heavy regional focus within Quebec, I think HEXO would suit the investor looking for that type of exposure,” says Udell.

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